Thursday, May 20, 2010

This chart has the best track record of signalling recessions of any that I'm aware of. The blue line is the real Fed funds rate, and the red line shows the slope of the Treasury yield curve from 1 year through 10 years. Every recession for the past 50 years has been preceded by a rise in the real Fed funds rate and an inverted (negatively sloped) yield curve. When real short rates are high and the yield curve is inverted, its because the Fed is aggressively tightening monetary policy, and this eventually strangles the economy.

Conditions today are the exact opposite, and point to continued recovery. The Fed is easy, real short rates are negative, and the yield curve is almost as steep as it's ever been (even though it has flattened somewhat today). It would be astonishing if a recession were to develop given how accommodative financial conditions are today. (And I note that conditions in Europe are quite similar to conditions here in the U.S.)

Re Richard Russell: I do consult charts from time to time, and I know they can be convincing at times. But I'm very reluctant to follow the advice of chart readers when I don't see any fundamental indicators backing them up.

In any event, I'm sure Russell's warning of impending doom is a factor behind the market's recent bout of nerves. There is no shortage of doomsayers these days.

If you are out there, you asked earlier about BP and would I buy it here.

I have walked away from Bp because of the oil spill (I hold no grudge, it was an accident) but I choose not to be a shareholder. However, I know of a very astute INVESTOR who is buying. I think it is the yield and the extreme negetive sentiment that attracts him.

I suspect that your analysis is correct, but at no time in the past 50 years has the U.S. economy been in a deleveraging situation (monetary contraction too -- gosh I would like for M3 to be still published). To see something similar you have to go back to the 30's and the 70s (1870s that is).

The usual tools of recovery don't appear to function. S/T Interest rates are low, and there is no recovery (aside from government expenditure), companies in the U.S. are reducing debt, reducing costs -- generating more profits (through an increase in productivity) but no top line growth.

The one modern comparison is Japan; after the 1987 crash, Japanese companies cut borrowing, top line growth went out of the window (BTW its not a very good comparison).

You know the phrase: This time its different -- this time, it may just be so.

Frozen: The weakness in M2 has been way over-hyped. If you take a long-term view, what you see is that M2 grew very fast and was way above its long-term trend from Q3/08 through Q1/09. It then slowed way down and is currently approaching its long-term trend once again. There is no evidence at all of monetary contraction.

Over the past 15 years M2 has grown on average about 6% per year. That compares to 5% nominal GDP growth and 2.5% inflation over the same period.

I would also note that there is no reason for deleveraging to lead to economic weakness. Growth is not built on leverage, it's built on productivity.

One euro company you likely can get in London is the Swiss drug giant Novartis (NVS). The yield is decent and they raise it regularly. They own a big hunk of Roach pharma, which owns probably the best biotech company Genentech. Someday NVS will own all of it. I think it is probably privately and informally understood that it will happen in time. Great generic drug business to go along with their pharma.

I believe the majority of the case the bears are using is the dreaded 'double dip' recession. I therefore think that IF our economy continues to grow at least at a 3% pace the current fears in the market will subside rather quickly. I was frankly surprised the panic was as intense as it was/is. The European troubles are serious but I think manageable in the short term. They are also rather plain compared to the complexities of the Lehman debacle. We are apparantly still too close in time to that event for many market participants to have the patience and pain tolerance to weather the storm.

So I think either the market finds a bottom pretty close to where we are and rises later in the year OR we go down considerably more. It largely will depend on how our economy performs.

You have picked one wooley beast to ride! US Steel (X) is a highly cyclical company tied to the business cycle. You are correct. It will reward you handsomely if we have the recovery Scott thinks we will have. But be ready to sell it when times get good again (IF they get good again!).